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South Korea Seeking Balance

03/25/2013

The late December reintroduction of the global carry trade, with the Japanese yen assuming the funding currency role, remains one of the strongest tailwinds for the current S&P 500® Index (SPX) appreciation. By selling the yen, speculators are very efficiently raising cheap capital to reinvest in global risk assets. One developed economy stands out as the best opportunity for that capital. Given the overwhelmingly best-in-class economic data being reported in the United States this year, capital is being deployed first and foremost in U.S. equity markets.

Investors should continue to monitor the direction of the yen; further declines preserve the strong tailwind for the SPX.

However, investors should also monitor the recent rhetoric from South Korea whose currency, the won (Figure 1.1), is appreciating rather uncomfortably in 2013 as the counter to yen weakness.

The Korean Stock Exchange (KOSPI) (Figure 1.2) is actually down (-2.4%) year to date as an appreciating won is hindering exports. Korea’s large auto and technology sectors are heavily reliant on strong exports. Overall exports were reported down 8.6% year on year recently. Despite new products, South Korean companies such as Samsung and Hyundai are declining year to date. Capital is flowing out of South Korea, as last week witnessed the largest outflow from South Korean equities since May 2012. No longer can these domestic challenges be ignored by President Park Geun-hye’s administration.

Over the weekend South Korea’s new finance minister, Hyun Oh Seok, issued strong communications that the yen’s weakness need be immediately addressed by the international community and the G-20 directly. I take the new administration’s intent rather seriously. Fiscal and monetary policy, in some regard, is too tight in South Korea. Should the complaints of South Korea officials to the international community remain unaddressed, investors should be prepared that South Korea’s own fiscal and monetary stimulus plan could diminish the declining yen tailwind.

Investors seeking investments in South Korea on expected stimulus should focus solely on the debt market, not the domestic equity market. Government debt runs relatively low at 39% of 2012 GDP. Its sovereign debt credit rating is Aa3 for Moody’s, AA- for Fitch, and A+ for S&P. Inflation is running slightly below 2%.

I expect multiple investment banks to begin commentary regarding the South Korean won versus the Japanese yen currency challenges. Investors should not take portfolio action yet, but don’t ignore the dialogue over the coming months either. Listen closely, and be prepared to potentially seek opportunity from any shifting monetary or currency policies.

Figure 1.1 South Korean Won, Prior 365 DaysSource: Bloomberg

Figure 1.2 South Koran KOSPI, October 2012 to PresentSource: Bloomberg

Past performance is not a guarantee of future results.

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